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Strategies & Market Trends : Zeev's Turnips - No Politics -- Ignore unavailable to you. Want to Upgrade?

To: J D B who wrote (32103)	2/25/2002 1:29:57 PM
From: Challo Jeregy	Respond to of 99280

Sorry for the delay, JDB It is a pay site, but I'm sure you are familiar with it - astrikos.com astrikos.com This was a further comment on Saturday re the trade- Saturday, February 23rd Continuing my discussion from Thursday concerning the institutional action in DJX options, I wanted to delve deeper into the trade to illustrate why it may have played a large part in tanking the market Thursday afternoon. If you check intraday put/call ratios for the DJX on Thursday, you'll see the big jump in put volume around Noon ET, and while that's very useful information to have, it doesn't tell you exactly which options were bought/sold and what the motives were behind the trade. To find out these kinds of details, it's necessary to check the time & sales data for the individual options. Here's what we uncovered... About 11:30am ET as the DJX was trading around the 99.75 area, an institution initiated what appeared to be a massive long calendar spread in the DJX March and May 98 puts. A long calendar spread is constructed by selling nearby puts (or calls) and buying further out puts (or calls) of the same strike. As you'll see from the examples below, when this kind of spread is initiated using puts, the largest profit will be realized if the underlying index is little changed at the time the nearby options expire. A large drop in the underlying will generate a loss, albeit a small one, while a big rally in the underlying will generate a substantial loss. A flat market will generate the largest profit. Here are the details of the trade... Approximately 11:30am ET on 02/21/02 25,000 DJX March 98 puts were sold at 1.20 25,000 DJX May 98 puts were bought at 3.00 On Thursday, implied volatility in DJX options was running around 22%. Assuming no change in volatility, the following scenarios are possible by the time the March options expire - the Dow will be unchanged, the Dow will be up or the Dow will be down. To illustrate how the long calendar spread performs under these conditions, I've calculated the prices of the DJX puts assuming the Dow is unchanged on March 15th, as well as the prices of the puts if the Dow is +500 next month or -500 next month. No change in price. DJX @ 99.75 Mar 98 puts worth 0... Profit of 1.20 May 98 puts worth 2.50... Loss of 0.50 Overall: Profit of 0.70 or 39% 500 point rally to DJX 104.75... Mar 98 puts worth 0... Profit of 1.20 May 98 puts worth 1.10... Loss of 1.90 Overall: Loss of 0.70 or 39% 500 point drop to DJX 94.75... Mar 98 puts worth 3.25... Loss of 2.05 May 98 puts worth 4.90... Profit of 1.90 Overall: Loss of 0.15 or 8% Notice that the largest profit is achieved if the Dow is unchanged come mid-March, because the short puts expire worthless while the May puts still retain a decent portion of their premium. While a small loss is shown above if the Dow falls 500 points over the next few weeks, it would more likely be a break-even or even better due to the fact that volatility will most likely have increased, pushing up the premium of the May puts beyond what I've shown. The only scenario in which the institution could really get hurt is if the Dow rallies hard over the next few weeks, because the May puts will have lost more than the 1.20 taken in by selling the March puts. Now remember that on Thursday afternoon, the Dow was in the process of rallying hard and was attempting to move back over the 10,000 mark. When this put spread hit the tape, those who saw it happen had a definite leg up on those who didn't. Why? Because the institution that initiated this trade obviously didn't believe the Dow would manage to keep on moving higher. By putting on such a large, basically bearish, spread as the market was charging higher, it was clear that some big money was betting on the rally failing. Those who saw the spread hit the tape were probably scared off from buying and/or even began selling aggressively. As word of the trade spread, the selling pressure intensified and sent the Dow down nearly 200 points over the next few hours. Some strange action in the April 98 calls right at the closing bell Thursday was hard to decipher, but was almost certainly related to the earlier put spread given the nearly identical size of the positions (a total of 50,000 April 98 calls traded at 4:14pm ET Thursday). Whether the initial calendar spread was the ultimate intention of the institution that made the trade, or whether it was part of a more complex strategy involving the April calls, one thing is clear. The institution must have known that the put spread would be looked upon as a big bet on the Dow rally failing, and whether they really believed that or not, you can bet that they used the subsequent selloff to their advantage. This is what I mean by manipulation.